By Suranjali Tandon, National Institute of Public Finance and Policy, New Delhi, India
India’s Central Board of Direct Taxes on August 28 published a consultation document on proposed rules (Rule 11UE) to give effect to recent tax law amendments removing the controversial retroactive application of a law taxing indirect transfers of assets situated in India.
Retroactive tax amendment
In 2012, taxpayers wailed at the introduction of explanations 4 and 5 to Section 9(1)(i) Income tax act 1961. The amendment not only expanded the scope of capital assets (Section 2(14) of Income Tax Act 1961) and transfers (Section 2(47)(vi) of Income Tax Act 1961) to which capital gains would apply, but also the amendment was to take effect from 1 April 1962. Many articles allude to the shortcomings of the legislation – that it applied to a broad range of transfers of shares in an entity with assets situated in India and that it was applied retrospectively.
The finance minister at the time expressed that the tax was needed not only to undo the Supreme Court’s decision in Vodafone case but also to check the erosion of revenue. The former was considered the primary reason for the amendment and thus taken in bad faith. In response to the criticism, the prime minister set up a committee to examine the legislation.
The Shome Committee reviewed the law and suggested that retrospective legislation may be used in rare and exceptional cases, where the intent of such legislation is:
first, to correct apparent mistakes/anomalies in the statute; second, to apply to matters that are genuinely clarificatory in nature, i.e. to remove technical defects, particularly in procedure, which have vitiated the substantive law; or, third, to “protect” the tax base from highly abusive tax planning schemes that have the main purpose of avoiding tax, without economic substance, but not to “expand” the tax base. Moreover, retrospective application of a tax law should occur only after exhaustive and transparent consultations with stakeholders who would be affected.
During consultations held by the Shome committee, stakeholders contended that the amendment was unreasonable and violated the right to equality before the law under Article 14 of the Indian Constitution. However, the report did not examine this issue in detail but suggested that retrospective amendments may be acceptable in the above-mentioned circumstances.
It is observed from review of global practices that the use of retroactive legislation is not uncommon. For example, the UK introduced a retrospective amendment of Section 58 of the Finance Act in 2008. This was to counter the tax planning scheme involving a foreign trust with UK resident trustees in combination with a partnership.
Typically, such amendments are either explicitly limited by the relevant country’s constitution or may be challenged on the grounds that these violate human rights conventions. In the UK, the retrospective amendment was challenged on grounds that it violated EHRC R(shine) v HMRC [2011] EWCA 892. However, the courts ruled in favour of the tax authorities since the taxpayer was exploiting a loophole in the law.
Though afforded the right, Cairn did not challenge the constitutionality of the amendment before the Indian courts. It would have been interesting to observe the interpretation of the courts had such a constitutional challenge been brought before it. It will remain a mystery if avoidance is seen at conflict with equality, thus undermining the claims that such amendment is unreasonable or disproportionate.
Tax demand was brought against Cairn UK Holdings Limited, and, in fact, the Income Tax Appellate Tribunal ruled in favour of the Revenue. While the dispute progressed to the High Court, the taxpayer invoked bilateral investment treaties to uphold fair and equitable treatment and protection from indirect expropriation.
In the nine years since the law was enacted, demands were raised from 17 companies, of which two have been stayed by the High Court and four invoked bilateral investment treaties. Cairn and Vodafone represented 14.5 percent of the demands raised. This was in line with the global trend – international investment arbitration pertaining to tax disputes increased significantly. Since the early 2000s, more than 30 cases were brought against states. The distinct advantage of the process is that, unlike tax disputes, the taxpayer is able to directly bring a claim against the sovereign.
In 2020, the arbitration tribunals awarded Cairn and Vodafone their claims. The orders precipitated matters, while companies prepared for enforcement, India conveyed that it would seek other recourse. It moved to further appeal before the Singapore court in Vodafone’s case and before the Hague court in Cairn’s case. India maintained the contention that the tribunal did not possess jurisdiction and the decision impinged on its sovereign right to tax.
Nevertheless, the taxpayers sought to enforce the order of the tribunal. In response, Cairn registered the award in multiple jurisdictions – US, UK, Canada, Singapore, Mauritius, France, and the Netherlands. It further froze India’s assets, which included government-owned property worth EUR 20 million, at the direction of the French court. At this point, the case had visibly reached an impasse.
To soothe tempers, the Indian government, in a surprise move, introduced the Taxation Laws (Amendment) Act 2021 in August to undo the retrospective application of the tax.
Undoing the retroactive tax
To resolve the pending litigation, that admittedly had turned out to be costlier than the revenue it was expected to bring, the government amended the tax law to remove the retrospective elements by removing the possibility of any scrutiny or reopening of past assessments on similar grounds. Furthermore, the government allowed taxpayers to claim a refund if they agreed to irrevocably withdraw or furnish a statement pledging withdrawal of pending litigation and furnish a further statement that it will not file any claim for cost, damages, interest, etc. Thus, the award that Cairn has enforced in various jurisdictions would have to be withdrawn.
Under the proposed rules, as per the public consultation document, the taxpayer would be expected to file the required statements within a specified period (45 days) from the date of notification. Upon receiving the statements from the declarant, chain of holding companies, and persons whose interest is directly and indirectly affected, and providing the declarant an opportunity to be heard, the principal commissioner or commissioner will pass an order accepting (or not) the undertaking within 15 days from the date of receipt of the statement and shall issue an order giving direction to the assessing officer to grant relief within 30 days.
Given the impasse, the proposed amendment and settlement is a well-crafted compromise. Cairn has expressed its intent to settle its claims of approximately USD 1.07 billion. The company intends to return up to USD 700 million of the refund to shareholders as special dividend to the tune of USD 250 million and buy back shares. Nevertheless, not all companies were enthused by the draft rules. There are apprehensions of the extent of compliance and extensive waivers from all interested parties with past or present interest.
As the government and taxpayers prepare to bury the hatchet, the decade-long dispute has many lessons for tax experts. One is that the narrative on tax policy is set predominantly by large taxpayers, and certainty among the many principles trumps equity. Another is that the distinction created by the arbitration tribunal between tax disputes and tax-related investment disputes may carry into the future. Safeguards need to be adequately built against such issues to avoid further litigation.
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